UK - Pension funds' assets will be asked to "sweat harder" as real yields on swaps fell below zero last week, investment advisory Cardano has warned.
Ralph Frank, head of solutions in the company's UK office, said schemes would be facing the "mental hurdle" of agreeing to a negative real rate through interest rate swaps in the UK.
But he called on investors to remain rational and consider carefully what their investment expectations for the future would be.
He noted that yields on interest rate swaps had fallen below 3.5% following concerns about European government debt and global market volatility and told IPE that it felt uncomfortable for many to lock into such negative real rates.
He also warned that these negative swap yields could persist "for some time".
"People tend to feel they can always earn a rate in excess of inflation, and by locking into these rates, now you are saying that, with certainty, you will earn a rate less than inflation," he said.
"In terms of pension scheme funding, you've then got to sweat the remaining assets that much harder to achieve your investment targets."
However, Frank stressed that investors were not bound to agree to both the nominal interest rate and the inflation component of such swaps, giving them some flexibility.
He also noted that index-linked gilts offered an alternative by trading between 30 and 40 basis points a year above current swap rates.
Frank conceded there was further downside risk if the economic situation deteriorated further, citing the "extreme examples" of Japan and Switzerland.
"The nominal rates could fall further, and if the inflation swaps trades remains sticky, then you've got a negative real yield coming up," he said.
Frank warned that, regardless of a potential reduction in realised inflation, market sentiment might still stop swap rates from adjusting accordingly.
"Even if the realised rate does come down in the next year, people might still be prepared to pay up for protection, and, in that way, keep the swap rate high," he said.